3 Mistakes to Avoid When Applying for a Home Equity Loan
A home equity loan can be a great resource to homeowners who need some extra money to do a renovation project, pay for college tuition, or even make a large purchase. However, there are three mistakes that you as a homeowner might make that, if avoided, can make the application process run smoothly and give you a better experience:
1. AVOID being unaware of the differences between a Home Equity Loan and a Home Equity Line of Credit. It is important that you understand the differences between the two types of home equity loans so you will know which one is better for your situation. A home equity loan is paid out in one lump sum and it usually has a fixed interest rate and term. A home equity line of credit, on the other hand, can be drawn on whenever you need money, interest is paid only on the amount you borrow, and it usually has a variable interest rate. Ascertaining how you will use the funds, what type of interest rates you would prefer, and how you can afford to repay the loan will force you to research these loans very carefully and will allow you to make the best decision.
2. AVOID getting hit with unexpected fees. Most fees on home equity loans and lines of credit are unavoidable, but it is still important to know about them, so you are not surprised when you are charged with them. Common fees that are charged on a home equity loan include closing costs, points, appraisal fees, escrow fees, flood certification fees, and recording fees. Some financial institutions will also charge customers a prepayment penalty fee if they close out the account before a certain time period - typically within the first three years. Home equity lines of credit carry most of these fees as well, and they also tend to have annual fees attached to them. Being prepared for these fees will allow you to include them in your estimate of how much you can afford to borrow, so that you do not end up owing more than you had expected.
3. AVOID jumping at the offer of a high LTV ratio. The loan to value (LTV) ratio is the ratio of the amount of money you borrow through a home equity loan (or mortgage) to the value of your home. This ratio is considered high when it exceeds 80%. Sometimes, if you have outstanding credit, certain lenders who want your business will offer you a loan for an amount close to or even exceeding the amount of equity you have in your home. The interest and any fees you might be charged can take a high LTV loan above the value of your home, making the excess amount an unsecured loan, like a credit card. The interest on this amount is not tax-deductible, as the interest on home equity loans and lines of credit usually is. (Check with your tax advisor for more details.) Only borrow what you can afford - do not take more money just because it is offered to you.
Being aware of these mistakes and knowing how to avoid them will certainly get you on the road to becoming a wise home equity loan shopper.
Source: Informa Research Services